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Japanese equities have been among the best performing global markets since late 2012.1 The depreciation of the yen and the rise in equity prices have been widely noted. But looking under the hood, we’ve noticed another important change occurring in Japan.

Japanese policy makers are attempting to break the stigma of Japan’s perennially low return on equity (ROE) to help revitalize their equity market.

How Might They Do It?

Japanese companies are known for keeping large cash balances—a practice well suited for deflation. Lowering these cash balances is one way to quickly increase ROE, and a powerful avenue to accomplish this would be increasing dividends. And while U.S. dividend growth has been tough to beat over the last year, Japan’s looked even better:

• Quality Focused: The other half of the selection criteria are based on the average return on equity and return on assets (ROA) over the past three years. By looking at both, we can mitigate the risk of becoming exposed to highly leveraged firms.

• Currency Hedged: Central bank policies—in particular those of the Bank of Japan (BOJ)—may lead to increased risk of fluctuating currency values. This Index hedges the impact of changes in the value of the yen against the U.S. dollar to mitigate this potential issue.

On January 6, 2014, the Tokyo Stock Exchange began calculating a new index, the JPX-Nikkei Index 400. Instead of simply including listed companies and weighting them by market capitalization, this index was among the first in Japan to select companies based on measures of profitability, corporate governance and other factors meant to incentivize “investor-friendly” practices.2